Transmission Mechanism of Monetary Policy Channels and Economic Growth in Ethiopia: Cointegration and Causality Analysis Approach

doi:10.7176/rhss/12-1-03

Abstract

This paper aims to investigate the relationship between transmission mechanism of monetary policy channel and economic growth in Ethiopia. Johansson co-integration, vector error correction model (VECM), Granger causality test were utilized for a time series data collected from 1972 to 2018. Broad money supply, real effective exchange rate and deposit interest rate have positive and domestic credit has negative effect on real economic growth in the long-run whereas in the short run broad money supply, real effective exchange rate have positive but, domestic credit and deposit interest rate have negative relationship with real economic growth. Real economic growth, broad money supply, domestic credit and real effective exchange rate have bidirectional causality whereas deposit interest rate has one directional causality with real economic growth, broad money supply, domestic credit and real effective exchange rate. Monetary policy transmission mechanisms channels are most important in promoting real economic growth in Ethiopia through creation of modern banking sector, so as to enhance domestic investment, the instrument to increase output per capital and hence promoting economic growth in the long-run. Keywords: Granger Causality, Johansson Co-integration, Monetary Policy, Time Series, Vector Error Correction Model (VECM) DOI: 10.7176/RHSS/12-1-03 Publication date: January 31 st 2022

Highlights

Monetary policy is the process by which the regulatory authorities, government and central bank of a country controls the rate of inflation, exchange rate, supply of money and rate of interest in order to achieve a set of objectives that is advantageous for the strength, stability and growth of the economy [1].The conduct of monetary policy in Ethiopia has gone through two distinct phases, before 1991 and after 1991
Study Variables This study focused on the relationship between transmission mechanism of monetary policy channel and real economic growth in Ethiopia based on secondary data which was collected from 1972 to 2018 including the variables Broad Money Supply (M2), Domestic Credit (DC), Real Effective Exchange Rate (REER) and Deposit Interest Rate (DIR) as a proxy of transmission mechanism of monetary policy channel and Real Gross Domestic Product (RGDP) as a proxy of real economic growth
The standard Augmented Dickey-Fuller (ADF) and the Philip Peron (PP) unit root test will be used to examine the stationary properties for the long run relationship of the times series variables [19]

Summary

Introduction

Monetary policy is the process by which the regulatory authorities, government and central bank of a country controls the rate of inflation, exchange rate, supply of money and rate of interest in order to achieve a set of objectives that is advantageous for the strength, stability and growth of the economy [1].The conduct of monetary policy in Ethiopia has gone through two distinct phases, before 1991 and after 1991. In 1990/91 following the fall of the autocratic government, EPRDF came to power with the idea of market oriented economy up on the adjustment programs of the international monetary fund and the world bank. The inception of economic reforms in the 1990s, saw the economy transform to a market-based system for promoting economic growth through agricultural farms, industries, financial institutions and banks are under its direct control. In such a way the central bank controls monetary policy variables on behalf of the government [2]

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